Climate change and competitiveness

Remarks by Angel Gurría, OECD Secretary-General, delivered at the Johns Hopkins School of Advanced International Studies, Global Energy and Environment Initiative

22 April 2010, Washington D.C

Ladies and Gentlemen:
It is a great pleasure to be at the Johns Hopkins School of International Studies to address one of the most pressing global challenges of our times: climate change.

The celebration of Earth Day is a good opportunity to reflect on the strong relationship between our economic performance and the delicate environmental balance of this planet.

Our civilisation is living beyond its limits. Our production and consumption patterns are causing irreversible damage to this earth and its atmosphere. If we carry on, our greenhouse gas emissions will accelerate global warming throughout the coming decades at an alarming rate, potentially resulting in a global environmental disaster of immeasurable consequences.

Secretary-General at Johns Hopkins University, Washington, DC.

It is time for a major cultural change. A better education alone won’t do the trick. To reverse climate change, we need effective and coordinated policies, inclusive global agreements, innovative multilateral tools and responsible enterprises.

1. Important progress… and a long way to go

Together, we have made important progress in the last years.

In September 2009, the G20 Leaders gathered in Pittsburgh took a first important step forward by pledging to phase-out inefficient and wasteful fossil fuel subsidies in the medium term. At that time, the G20 Leaders requested the OECD, the IEA, OPEC and the World Bank to carry out further analysis. Our draft report, just delivered to G20 Finance Ministers, provides data on the scope of energy subsidies together with practical advice to countries on how to phase them out.

Three months later, the Summit in Copenhagen took a critical step towards a post-2012 agreement on climate change. With the inclusion of the main emitters, with their targets and or actions, the Copenhagen Accord was an important breakthrough towards collective international action to limit global emissions, and to help build cleaner economies. It was far from perfect, and we would have liked to achieve more, but it is a solid starting point.

These are paramount achievements, but the biggest steps are still in front of us. Let me highlight three key challenges:

1. First, the most ambitious of the declared targets by industrialised countries add up to an 18% reduction in their emissions by 2020 (from 1990 levels). This falls short of the 25 to 40% reduction that scientists say is needed to keep the temperature rise to 2°C. We need to increase these targets.

2. Second, financing also needs to be scaled up. There was some progress at COP 15, but more is needed. Gradually building-up a global carbon market will be critical to provide incentives for private finance. Market-based instruments, such as carbon taxes and auctioned permits in emissions trading schemes, could also bring significant revenues, some of which could be used to finance climate change action in developing countries.

3. Third, in order to achieve tangible progress, mitigation actions and mitigation support should be “measurable, reportable and verifiable”. More needs to be done on this front too, in order to ensure transparency and accountability in climate change efforts.

One of the main obstacles to make progress in addressing these and other crucial climate challenges relates to concerns around the possible impact of policy commitments on competitiveness.

Let me share our perspective on this major global preoccupation.

2. The fear of losing competitiveness: the obstacle

OECD analysis shows that the most cost-effective way to mitigate climate change is to gradually build up a global price signal on carbon, through the use of market mechanisms such as cap-and-trade systems and carbon taxes.

Many OECD countries participate in the European Union Emission Trading Scheme, but its ambitions have been somewhat undermined by competitiveness concerns. Other countries, such as the United States, Japan and Australia are facing persistent political difficulties in establishing a clear price on GHG emissions, due to the same reasons.

Some industries fear that cap-and-trade or similar domestic policies would put them at a disadvantage with foreign competitors from emerging economies which may not be subject to similar constraints. Another related concern is that efforts to reduce emissions in one country may be undermined by increased emissions elsewhere ─ the so called “carbon leakage”.

These fears have led to calls in some developed countries for taxes on imports from countries lacking stringent GHG targets, the so called Border Tax Adjustments (BTAs). In the United States, for example, carbon-based BTAs are in both the Waxman-Markey bill, passed by the House of Representatives, and the Kerry-Boxer bill proposed in the Senate. In Congress, competitiveness concerns were expressed to President Obama in a letter from nine Democrat Senators (of December 2009), asking to establish a national system of border adjustments.

So competitiveness concerns clearly have political ramifications on climate policy.

3. But, are these concerns fully justified?

We think not. Let me give you some reasons.

Firstly, recent OECD analysis shows that carbon leakage tends to be rather limited. In fact, it tends to diminish as mitigation action and carbon markets expand. If the European Union, for example, were to cut emissions unilaterally by 50% in 2050 (from 2005 levels), nearly 12% of total EU emissions reduction achieved would be off-set by emissions increases elsewhere. But if all industrialised countries took action to reduce emissions, then this “leakage rate” would be reduced to just 2 %.

Secondly, carbon leakage could occur not only due to shifting production but also through a second indirect channel. If climate policies induce weaker energy demand, a downward pressure exerted on global energy prices will in turn increase demand for GHG-emitting fuels in locations where emissions are not constrained. While BTAs might be effective in addressing leakage due to shifts in production, they cannot address leakage due to changes in fuel prices.

Furthermore, OECD analysis shows that BTAs may not curb the output losses incurred by domestic energy-intensive industries. Therefore, they appear ineffective in addressing competitiveness concerns. In certain cases, BTAs can actually make things worse for these industries through negative impacts on exchange rates and terms of trade.

Here in the US, I note an interesting interagency report that shows that the competitiveness impacts of the Waxman-Markey proposal are likely to be limited to a small portion of the economy – this is without taking into account the allowance allocation and the BTA measures in the proposal. This is unsurprising, given that energy expenditures account for less than 2% of US manufacturing output value.

We therefore think that fears of competitiveness loss and carbon leakage might be exaggerated, and BTAs are unlikely to be an effective means of addressing costs in those rather limited sectors, which might be affected.

Beyond the economic sphere, BTAs also pose diplomatic risks for international negotiations. The introduction of BTAs by developed countries could severely damage the goodwill and trust of developing countries in key negotiations. India, China and the G-77 have already been calling to introduce text in the UN climate negotiations to caution against BTAs and other countervailing border measures.

At the same time, BTAs would also be technically difficult to implement. There is no agreement on how to account for the emissions embodied in a given manufactured product. Imagine having to calculate the embedded carbon content of a toy or a tonne of steel coming from other countries, given the differences in production methods and efficiencies as well as in energy generation across trading partners. The complexities would create the potential for distortion, discrimination and double taxation, raising serious questions about feasibility.

So what are the alternatives to BTAs? Here are some ideas that can help us answer this question:

Of course, the first best approach is to have a completely level playing field by ensuring action on climate change by all countries. Lacking that, our analysis suggests that competitiveness concerns could be addressed with well targeted measures designed to ease the transition for the affected industries, without having to resort to Border Tax Adjustments. For example, revenues from carbon taxes or auctioned emission permits could be recycled back to the affected sector in ways that would not undermine the incentive to reduce emissions. This could help to stimulate innovation and the application of green technologies to reduce the carbon footprint of that particular sector.

Another avenue to level the playing field is international co-operation within energy-intensive sectors of industrialised and emerging economies. Action in these sectors is crucial. Recent OECD analysis shows that exempting energy intensive industries from carbon pricing would raise the costs of achieving even a moderate target by 50% in 2050.

It would also be very important to work with the most exposed sectors to allay fears where they are unwarranted and find creative ways to assist with the transition where the problems are real. Governments need to put in place measures to smooth the transition in sectors that might be negatively affected, while seizing new “green growth” opportunities, technologies and jobs.

Ladies and gentlemen:
Cutting GHG emissions will inevitably involve a restructuring of the economy. Government policies must play a key role not only to enhance the competitive edge of “green” industries, but also to smooth the transition for those that may be negatively affected. Before addressing alleged problems, we need to make sure they are well documented and decisions are made on the basis of clear evidence.

As I mentioned at the beginning of my presentation, there are many challenges to build a comprehensive international framework to address climate change. But if domestically we are able to make progress in dealing with competitiveness concerns, this will take us a good way forward. We, at the OECD, with several decades of experience in dealing with climate change and a recent mandate to develop a Green Growth Strategy, are ready to continue contributing to inform the debate. I welcome your comments and questions.